ANALYSIS-Lack of standardisation hobbles Islamic finance

By Reuters Staff
May 10, 2010

By Shaheen Pasha and Liau Y-Sing

DUBAI/KUALA LUMPUR, May 10 (Reuters) – Wrangling among scholars and wiggle room in interpretation of Sharia principles threaten to derail any attempt to arrive at global standards in Islamic finance, holding back the $1-trillion industry.

Analysts say that unified rules that could have fuelled growth will be difficult to establish given the differences not just between regulators but also between practitioners.

Many global Islamic finance institutions currently look towards guidelines set by Accounting and Auditing Organization for Islamic Financial Insitutions (AAOIFI) but there is no way to force banks or the sharia boards to comply in all cases.

“By default, we expect sharia scholars at individual banks to stick to the standards we have issued but there is always the possibility that people can deviate,” said Mohamad Nedal Alchaar, Secretary General of AAOIFI. “We just don’t have the enforcement power.”

A series of high-profile defaults and a legal battle over the sharia compliance of a contract between Kuwait’s Investment Dar and Lebanon’s Blom Bank have raised calls for standardisation, particularly as Western markets that are used to more regulation eye entering Islamic finance.

Blom sued Investment Dar in a British court last year to receive its principal and a fixed return promised in its contract with Dar. Dar declared the deal void despite its own sharia board approving the structuring, saying that under sharia, a return could not be guaranteed because there was no risk-sharing.

One Gulf-based Islamic banker said that there was “real concern” among the conventional banks over the absence of an authoritative centralised body to frame rules.

“Islamic finance was originally about establishing an Islamic economy but we don’t even have synergy between banks in Malaysia and the GCC (Gulf Cooperation Council),” he said.

Standardisation bodies do exist but the adherence to their standards varies from country to country.

AAOIFI has 41 accounting and governance guidelines for Islamic financial institutions. Individual regulators in Bahrain, Qatar, Syria and Sudan made the standards mandatory for Islamic financial institutions but they are merely considered advisable in countries such as Malaysia, Saudi Arabia and the United Arab Emirates.

“There is cognisance that if Islamic finance is to grow between the Middle East and particularly Malaysia, there needs to be more dialogue and more consensus of how we can work together,” said Ariff Tun Dr Ismail, associate director at Maybank Investment.

Islamic finance is a $1 trillion global industry but ratings agency Moody’s forecasts that the industry could hit $5 trillion over time.

(For a FACTBOX on Islamic finance regulations around the world, please click here)

LENIENT MALAYSIA, HARDLINE SAUDI

In Malaysia there is a national sharia council that sets rules for Islamic financial institutions. But Malaysian interpretation of sharia is considered to be more liberal than the views of Saudi Arabian scholars, making it difficult to reach consensus on deals between the two nations.

Tawarruq, where an asset is sold to a purchaser with deferred payment terms and the purchaser then sells the asset to a third party to get funds, has sparked debate among scholars over its sharia-compliance.

The International Council of Fiqh Academy in Saudi Arabia declared tawarruq impermissible last May, calling into question deals in a market estimated to be worth over $100 billion.

But tawarruq is still widely used, particularly in Malaysia.

Some Islamic finance players say standardisation is an unrealistic goal given the fragmented nature of Islamic finance as compared to conventional banking, where there is greater compliance and agreement with industry standards such as Basel capital adequacy guidelines.

They warn that while conventional banks can fall in line with Basel II and International Financial Reporting Standards as well as their local country financial regulations, Islamic banking is dependent on varied interpretations of sharia as well as local laws.

And rejigging individual regulatory systems, monetary policies and religious interpretations into one set standard would require all markets to scrap their current system and start from scratch, raising costs.

“How can you have a one size fits all solution for the industry?” said Afaq Khan, chief executive of Dubai-based Standard Chartered Saadiq. “In theory, it’s a great idea but in reality, it would increase the costs for solutions to customers and push them away into a parallel economy.”

The silver lining is that the variations could lead to innovation.

“The Islamic finance industry has had about 6,500 fatwas and with 95 percent of them, there is consensus,” said Iqbal Khan, chief executive at Fajr Capital.

“The 5 percent where the difference lies gives us hope that there will be more innovation. That 5 percent is very important for change and evolution in the industry,” he added.

(Reporting by Shaheen Pasha and Liau Y-Sing; Additional reporting by Cecila Valente; Editing by Sitaraman Shankar)

((shaheen.pasha@thomsonreuters.com; Dubai Newsroom +971 439 18301))

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